Dollarization debate needs to be framed in frank examination of options, Calvo counsels
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Calvo: If the realities of emerging market economies are fully considered, a fixed exchange rate regime might offer an attractive option.
Experience with dollarization is so limited, and empirical data so scant, that any definitive assessment of it at this stage is foolhardy, according to Guillermo Calvo of the University of Maryland. But, addressing an IMF Institute seminar on May 11, he noted that current circumstances do provide the ingredients for an “interesting debate.” He counseled taking a fresh look at the assumptions shaping this debate, stressing that his presentation would focus on “how to think about these issues” rather than on conclusive recommendations. He did suggest, however, that analysts and policymakers take a hard look at the real options for exchange rate regimes in emerging economies. What they may find, he said, is that floating regimes may be more illusion than fact and that fixed rates, particularly full dollarization, might emerge as a sensible choice for some countries, especially in Latin America.
A number of questionable assumptions, Calvo warned, are muddying the ongoing debate over dollarization. In the aftermath of major financial crises in the previous decade, fixed exchange rates have fallen out of favor, and dollarization is frequently viewed as a drastic measure, requiring, among other things, the surrender of the central bank’s ability to function as a lender of last resort. But dollarization may not be the sharp departure from existing practices that its critics assume. Partial dollarization, for example, already characterizes a number of Latin American economies, he explained. Analysis of this issue commonly focuses on deposit (asset) dollarization, but debt (liability) dollarization is equally important. Individual borrowers with foreign exchange–denominated debts not matched by foreign exchange–denominated assets can be forced into bankruptcy by any depreciation of the exchange rate. The presence of such currency mismatches may argue for full dollarization.
If the merits of dollarization are to be weighed frankly, Calvo noted, it is useful to broaden the discussion and examine the realities in which exchange rate regimes operate in emerging economies. According to Calvo, a structural shift occurred in financial...
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